A World Awash in Cash

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One of the world’s biggest investors is now crying about having too much cash and nothing to buy with it.

Recently, Buffett’s Berkshire Hathaway announced enormous operating profits of $4,190 per Class A share. But the bigger story comes not from the income statement, but Berkshire’s balance sheet.

The company reported it is sitting on $130 billion in cash right now. That’s enough to outright buy nine out of the 30 stocks in the Dow Jones Industrial Average. And that’s just what Buffett would like to do with this cash.

Back in February, he told investors his goal was to make “one or more huge acquisitions” this year. So far, he hasn’t found any to buy.

The reason is simple: stocks are seemingly expensive these days. Just take a look at the S&P 500. Right now, the index’s companies are averaging a price-to-earnings (P/E) ratio of 24.7. That means it would take nearly a quarter of a century’s worth of profits for the 500 components of the S&P 500 to buy each of those companies out.

Historically, the average S&P 500 company traded at around 17 times its earnings. Buffett, the world’s most famous value investor, typically only buys shares of companies when they are trading at less than 15. So, the most basic of math here says stocks are trading about 45% higher than they should and 65% higher than Buffett would like to buy them for.

He’s not the only one with this dubious problem of too much cash. A few weeks ago, we wrote that Wells Fargo CEO Tim Sloan was having the same problem. During his second quarter earnings call he told investors, “Not much movement in customers revolving credit. Customers are just so liquid these days.”

You know there’s too much cash when you have banks say they wish more people would borrow some money from them.

It should also be no surprise that other major companies are floating in too much cash, not just investment firms. Apple has historically kept a huge amount of cash on hand, mostly overseas. As of May 1, the company has a reported $267.2 billion in cash. That’s more than a quarter of its trillion-dollar valuation.

So, what’s an investor to do in these times? Where should you deploy your own money when everything seems too expensive? Well, it might not be so clear without a little digging.

One often-overlooked part about investing is that you aren’t betting. You are investing in future earnings of that company and its assets. Since cash is becoming the number one asset for many companies like Buffett’s Berkshire Hathaway and Apple, an investment in either of those is like investing in those cash piles.

Now, we’re not saying you should definitely go out and buy either one of those plays. But valuing companies like these two can get a bit tricky with all that cash.

Since Apple’s just broke the $1 trillion market cap roof, we’ll use it as our example.

Instead of taking Apple’s market cap and dividing it by its earnings to find its P/E ratio, take out the cash first.

Without taking out its cash, Apple’s P/E would be 17.8 ($1 trillion divided by $56.1 billion in earnings). But if you discount for the ocean of cash in the company’s coffers, it’s P/E falls to 13.1($1 trillion minus $267.2 billion in cash and then divided by $56.1 billion in earnings).

That’s below the historical average for the S&P 500 and Buffett’s usual valuation limit. And once you consider that Apple is still a high growth type play, that’s actually a remarkably low valuation.

Berkshire’s numbers are even more amazing. The company’s regular P/E is 10.7, a very low number, but not surprising for this slow-moving behemoth. But once you discount the cash, its ex-cash P/E ratio falls to just 8.

While we’re not necessarily recommending you jump into either of this plays, they are great examples of how you need to look at investing in this cash-rich world.

If you are a value investor and looking to pick up some new investments, consider cash in whatever model you use. It is starting to clearly make a big difference in how we value stocks.

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